| Greece Defaults; Krugman Screams It's 1937; Maastricht Treaty Needs Revisions; "European Monetary Fund" Created; German Taxpayers on the Hook Posted: 21 Jul 2011 09:27 PM PDT The EU summit hammered out yet another temporary fix today, albeit a complicated one. The proposal involves the creation of a "European Monetary Fund" and it will require changes to the Maastricht Treaty. Paul Krugman does not like the austerity measures and ECB president Jean-Claude Trichet had to eat his words regarding defaults and acceptance of defaulted bonds as collateral. German taxpayers may potentially be screwed big time on this bailout. Can this agreement hold together? Before deciding let's look at some details. "European Monetary Fund" CreatedIn what French President Nicolas Sarkozy likens to a "European Monetary Fund", EU Leaders Offer $229 Billion in New Greek AidAfter eight hours of talks in Brussels, leaders announced 159 billion euro ($229 billion) in new aid for Greece late yesterday and cajoled bondholders into footing part of the bill. They also empowered their 440-billion euro rescue fund to buy debt across stressed euro nations after a market rout last week sparked concern the crisis was spreading. The fund can also aid troubled banks and offer credit-lines to repel speculators.
The euro strengthened as officials drew concessions from Germany, the European Central Bank and investors for a twin- track strategy to support Greece and ensure its woes don't spread. The summit is the latest in a running-battle to resolve the crisis amid calls this week for tougher action from U.S. President Barack Obama and the International Monetary Fund.
The Greek financing package will consist of 109 billion euros from the euro region and the IMF. Financial institutions will contribute 50 billion euros after agreeing to a series of bond exchanges and buybacks that will also cut Greece's debt load, the leaders' communiqué said.
French President Nicolas Sarkozy compared the transformation of the bailout fund to the creation of a "European Monetary Fund."
The pact still doesn't "make a significant dent" in Greece's debt and may disappoint investors by failing to boost the size of the rescue fund, said Jonathan Loynes, chief European economist at Capital Economics Ltd. in London. "We doubt that this package alone will bring an end to recent contagion effects and prevent the broader debt crisis from continuing to deepen over the coming months."
For now, Merkel and her allies have succeeded in their drive to make investors co-finance bailouts after voters balked at the cost of saving spendthrift nations.
Banks will reduce Greece's debt by 13.5 billion euros by exchanging bonds and "potentially much more" through a buyback program still to be outlined by governments, said the Institute of International Finance, a Washington-based group representing banks.
Trichet signaled governments will guarantee any defaulted Greek debt offered as collateral during money market operations. That may enable Greek banks to keep tapping the ECB for emergency funds. Officials said the aim would be limit any credit event to a few days.
The facility will be able to buy debt directly from investors so long as creditors agree and the ECB declares "exceptional financial market circumstances." EU President Herman Van Rompuy said the purchases could be used to stabilize markets as the ECB was doing or to help countries retire debt at a discount.
The fund may also start passing money to countries to support banks a week after stress tests on 90 financial institutions put as many as 24 under pressure to show they can raise capital. Precautionary credit lines would allow it to lend to nations before markets freeze, mimicking a system introduced by the IMF for states that start losing investor faith even though they have relatively sound economies.
Governments will have to ratify the facility's new powers, posing a potential obstacle given domestic critics in Germany, Finland and the Netherlands. One Step Closer to Nanny StateIf Germany, Finland, and the Netherlands foolishly approve this, it will be one step closer to the European Nanny State that Germany has feared so long. German Taxpayers on the HookZeroHedge comments 82 Million Soon To Be Very Angry Germans, Or How Euro Bailout #2 Could Cost Up To 56% Of German GDPThis is not a restructuring of existing debt from the perspective of the host country! Simply said Greek debt will continue growing as a percentage of its GDP, meaning it, and Ireland, and Portugal, and soon thereafter Italy and Spain will be forced to borrow exclusively from the EFSF.
In a just released report by Bernstein, which has actually done the math on the required contributions to the EFSF by the core countries, the bottom line is that for an enlarged EFSF (which is what its blank check expansion today provided) to be effective, it will need to cover Italy and Belgium.
[Bernstein]
An extension of the EFSF to cover Italy and Spain would require a €790bn (32% of GDP) guarantee from Germany
This strategy is not only unlikely to succeed but would also run into some serious structural difficulties. To cover 100% of the roll-over for Greece, Portugal, Ireland, Spain, Italy and Belgium as well as an allowance for bank support at 7% of the banks' balance sheets until the end of 2013, the support mechanism(s), would need to be able to deploy a total of €2.4trn in available funds. 1937 ReplayPaul Krugman is unhappy with the deal and is screaming 1937! 1937! 1937!The Telegraph has a leaked draft of the eurozone rescue plan for Greece. The financial engineering is Rube Goldbergish and unconvincing. But here's what leaped out at me:
9. All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances. Deficits in all countries except those under a programme will be brought below 3% by 2013 at the latest.
OK, so we're going to demand harsh austerity in the debt-crisis countries; and meanwhile, we're also going to have austerity in the non-debt-crisis countries.
Plus, the ECB is raising rates.
The Serious People are determined to destroy all the advanced economies in the name of prudence. Greece DefaultsFelix Salmon has a nice comprehensive wrapup of the new agreement in his post Greece Defaults. The latest Greek bailout is done and it involves Greece going into "selective default," which is, yes, a kind of default.
This is a bail-in as well as a bail-out: while Greece is getting the €109 billion it needs to cover its fiscal deficit, both the official sector and the private sector are going to take losses on their loans to the country.
As such, it sets at least two hugely important precedents. Firstly, eurozone countries will be allowed to default on their debt. Secondly, a whole new financing architecture is being built for Greece; French president Nicolas Sarkozy called it "the beginnings of a European Monetary Fund."
The nature of massive precedent-setting international financing deals is that they never happen only once. One thing is for sure: these tools will be used again, in future. They will be used again in Greece, since this deal is not enough on its own to bring Greece into solvency; and they will be used in other countries on Europe's periphery too, with Portugal and/or Ireland probably coming next.
The Maastricht treaty will get resuscitated, with all eurozone countries except Greece, Ireland and Portugal committing to bring their deficit down to less than 3% of GDP by 2013. Paul Krugman is screaming about this, but this was a central part of the eurozone project from the get-go, and clearly the eurozone needs some kind of fiscal straitjacket for its constituent members to prevent the rest of them from running up enormous deficits and then getting bailed out by Germany.
Finally, the EU will provide "credit enhancement" for Greece's private-sector bonds. This is a central part of the default plan, and it looks a lot like the Brady plan of the late 1980s. The official statement from the IIF, which is representing private-sector creditors in this matter, is a little vague, but essentially if you're a holder of Greek bonds right now, you have three [four] choices.
- You can do nothing, and hope that Greece pays you in full and on time.
- You can extend your maturities out to 30 years, and accept a modest coupon of 4.5%; in return, your principal will be guaranteed with an embedded zero-coupon bond from an impeccable triple-A-rated EU institution, probably the EFSF.
- You can extend your maturities out to 30 years, take a 20% haircut, and get a higher coupon of 6.42%; again, the principal is guaranteed with zero-coupon collateral.
- You can extend your maturities out to 15 years, take a 20% haircut, get a coupon of 5.9%, and have only a partial principal guarantee through funds held in an escrow account.
There is much more in Salmon' s article regarding what exactly is happening and what the options are. It's worth a closer look. Inquiring minds may also wish to consider the Official Statement by the EU. Three Critical Points- The critical point from Salmon is "The nature of massive precedent-setting international financing deals is that they never happen only once."
- The critical point from Bernstein is the amount German taxpayers will be on the hook once Salmon is proven correct.
- The critical point from Krugman involves short-term pain. Even if one disagrees with Krugman in the long haul (as I do), the short-term pain for Spain, Portugal, Ireland, Greece, and Italy is likely to be unbearable.
In light of the above, let's return to the question I asked earlier: Can this agreement hold together? I don't see how it can. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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| EuroZone Manufacturing Barely Above Contraction Posted: 21 Jul 2011 10:22 AM PDT Amidst all the euphoria over saving Greece for the nth time, the global economy continues to slow. Please consider Euro-Region Manufacturing Growth WeakensEuropean services and manufacturing growth weakened more than economists forecast to the slowest pace in almost two years, adding to signs the euro-region recovery is losing momentum as the debt crisis persists.
A composite index based on a survey of euro-area purchasing managers in both industries fell to 50.8 in July from 53.3 in June, London-based Markit Economics said today. That's the lowest since August 2009. Economists forecast a drop to 52.6, the median of 17 estimates in a Bloomberg News survey showed. A reading above 50 indicates growth.
"We expect the euro-region recovery to lose momentum over the coming months," said David Kohl, deputy chief economist at Julius Baer Group in Frankfurt. "The German boom is mainly export driven and the global economy is also cooling. The second half will be significantly weaker overall." Exclude Germany and the Eurozone is contracting already. Expect to see an overall contraction next month. Also note that China PMI in Contraction; IMF Wants Further China Tightening to Combat InflationWhatever the EU comes up with today will not fix the Eurozone structural problems or the US deficit problem. Nor will it address the problems of an overheating Chinese economy. The market however always seems to appreciate news of another bailout. One day that will not be the case. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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| Temporary Default Included in "Marshall Plan"; Role of EFSF to Dramatically Increase Posted: 21 Jul 2011 07:22 AM PDT It appears Jean-Claude Trichet is about to have the word "default" stuffed down his throat. YahooFinance reports Eurozone set for Greek deal, temporary defaultEuropean leaders were poised to sign off on a second bailout for Greece on Thursday, even at the cost of making the country the first euro state to partially default on its debt.
With the new rescue program, leaders want to "address the problems really at the root," by lightening the country's debt burden and restoring its economic competitiveness, German Chancellor Angela Merkel said as she arrived at an emergency summit in Brussels.
That will include getting private creditors to contribute to new aid, a move that would put Greece in so-called "selective default," a partial renege on its debt deals.
Dutch finance minister Jan Kees de Jager said objections "to avoid a selective default ... have been swept from the table." Speaking to lawmakers in The Hague, de Jager said the plan for Greece would "do something for the debt duration and also lower the debt burden."
Few economists believe that even with more support, Greece will be able to repay its debt -- some euro340 billion ($483 billion) -- without some kind of cut to the overall value.
However, so far the eurozone has ruled out forced haircuts on Greece's debt, fearing that it would heighten panic on financial markets and destabilize larger economies like Italy or Spain.
Instead, the 17-country currency union has been working on an alternative support plan that will see banks and other private investors give Greece more time to repay its bonds, while the eurozone and the IMF will continue to prop up the country with rescue loans.
For a few days this week, the eurozone had hoped that it could stay clear of a selective default rating by instead recouping some of the money they spend on new loans for Greece through a tax on financial institutions. Yet that plan, strongly opposed by banks that don't hold Greek bonds, did not survive last-ditch talks between Merkel and French President Nicolas Sarkozy Wednesday night. Look for Trichet to come up with some lame reason why the ECB will be able to temporarily hold defaulted bonds. Alternatively the ECB will be bailed out by selling them to the EU's EFSF, the European Financial Stability Facility whose role is about to get much bigger. I must caution there are still no firm details, likely on purpose. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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| Former ECB President Calls Backers of Common Bonds "Euro Gravediggers"; Red and Blue Bonds? Merkel to Embrace Common Bonds? Posted: 21 Jul 2011 06:52 AM PDT Lots of rumors are circulating this morning including still undisclosed agreements between German Chancellor Angela Merkel and French President Nicolas Sarkozy, more talk of Greek default from Jean-Claude Juncker, discussion of a "Marshall Plan" for Greece, guarantees of Greek debt and an expansion of the size of the EFSF as well as the EFSF being allowed to buy bonds in the secondary market. That so many rumors are circulating, I wonder if Merkel and Sarkozy have really agreed to do much more of anything than agree to agree. The granddaddy speculation of them all is the possibility Merkel might drop her opposition to common Euro bonds. That is the "nanny state" option I have written about many times recently. Euro Gravediggers and the Nanny State Fearing the common bond nanny state possibility, Otmar Issing, former ECB president issued a statement called the backers of common bonds "Euro Gravediggers". Please consider Merkel Drive to Save Euro May See Joint Bond Surrender as Crisis SpreadsGerman Chancellor Angela Merkel may need to abandon her opposition to issuing common bonds in order to stop a debt crisis that is threatening to splinter the euro region.
Merkel, who calls the single currency a "work of peace" and part of Europe's "uniting idea," is the key holdout on so- called euro bonds.
"Once they look into the abyss of a major speculative attack on Italy," Merkel will have to embrace euro bonds, Peter Bofinger, a member of the chancellor's Council of Economic Advisers, said in a telephone interview. "That would be the turning point. There needs to be a joint guarantee for all outstanding debt."
Political Union
France sees little room for a common bond without more integration of Europe's fiscal and budgetary regimes, a French official said. German Deputy Foreign Minister Werner Hoyer said it will require a closer "political union."
"If we further develop the European Union toward a political union, then the question of liability via euro bonds is an option," Hoyer said in an interview today. German constitutional rules bar the introduction of the debt instruments currently, he said.
"It's a fact of life that common currency areas have subsidies from the rich to the poor," said Marchel Alexandrovich, an economist at Jefferies International Ltd. in London. "You need euro bonds for the show to go on."
Euro Gravediggers
Eighty-six percent of Germans are concerned about the value of their savings and 47 percent want Greece evicted from the euro area, according to a poll for ZDF public television published last week.
Politicians who back measures such as common bonds "will prove to be the euro's gravediggers," Otmar Issing, the European Central Bank's former chief economist, said in a July 19 interview in the Frankfurter Allgemeine Zeitung newspaper. "The consequences of this policy will strangle Germany."
A compromise proposed by the Brussels-based research group Bruegel would see countries fold debts up to 60 percent of gross domestic product into a joint "blue" bond. That would likely enjoy relative lower interest rates than even low-deficit governments now pay, in part because of the more liquid market.
Any excess debt would then be sold on a national basis as a "red" bond with a higher yield.
"I'm growing more sympathetic to the red-blue bond approach," said Gilles Moec, co-chief European economist at Deutsche Bank AG in London. "You want a combination of accommodation and incentives for fiscal discipline."
Final Straw
Euro bonds may become inevitable, said Frank Schaeffler, a lawmaker for Merkel's Free Democratic Party coalition partner, who predicts Greece will succumb to a temporary exit from the euro region.
They "would be the last straw and Merkel knows it," he said in an interview. "The reality is we're steaming ahead into euro-bond land, it's just a few stations down the line. We may not be about to create instruments that are called euro bonds but don't be fooled by the labels." Red and Blue Bonds?When it comes to talk of red and blue bonds you know those involved have lost their collective minds. Regardless, the number of folks screaming for adoption of the European Nanny State continues to climb. For more on the Nanny State, please see... Support for Nanny State Now EntrenchedAmong the Eurocratic fools controlling things, support for the Nanny State Eurocracy is now approaching "critical mass". The only thing stopping common bonds is such a change would require a major overhaul of Maastricht Treaty that created the European Union, and a fresh vote by every country. Common bonds would also require changes to the German constitution. Would German voters go along? Loan ExtensionsThe most believable of all the rumors circulating involve loan extensions. Please consider Spanish, Greek, Italian Bonds Rise, Bunds Slump on Loan Extension ReportSpanish, Greek and Italian 10-year bonds jumped while bunds slumped after a media report said a draft document of conclusions from the European Union summit today calls for an extension of bailout loans for Greece.
Loans from the European Financial Stability Facility may be lengthened to 15 years from 7 1/2 years and offered at a rate of 3.5 percent, according to the Reuters report. Yields on benchmark German bunds climbed to the highest in almost two weeks after German Chancellor Angela Merkel and French President Nicolas Sarkozy agreed on a joint position to solve Greece's debt crisis. Luxembourg Prime Minister Jean-Claude Juncker said a so-called "selective default" is a possibility for Greece.
German Deputy Foreign Minister Werner Hoyer said Germany may back common euro bonds in the future as legal rules bar such a move for now. Loan extensions will not solve a thing but they will help did a bigger hole. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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